BlueScope grasps the nettle

BlueScope Steel
’s historic decision to withdraw from the steel export business, with the loss of about 1000 jobs and about $500 million in one-off costs, brings Australia to the pointy end of the economic restructuring caused by the surge in the dollar.

The early signs were that the federal government was not well prepared for an event that had been coming for a long time. Its immediate response was focused on the financial recompense for BlueScope workers rather than a broader strategic response for the Illawarra community of NSW, which is already struggling with a 7 per cent unemployment rate and one of the highest levels of youth unemployment in Australia at 19 per cent.

It is frankly disappointing that the first significant government res­ponse to the negative flow-on effect of the record terms of trade to the manufacturing industry was a standard off-the-shelf solution.

The government said it would launch a $30 million innovation and investment fund, but there was little detail about how it would work. The office of the Minister for Innovation,
Kim Carr
, said last night the fund would enter into contracts with companies to create “new sustainable jobs and diversify the local ­economy". The fund is the standard structural adjustment response that has been rolled out over the past seven years whenever a community is hit with big job losses.

This is a far cry from the seminal economic reform packages of the 1980s that not only led business towards restructuring but opened the door to growth in new industries such as financial services.

The innovation fund launched in response to the BlueScope crisis is slightly different to others in the past in that it has a $20 million contribution from the federal government, a $5 million contribution from the NSW government and $5 million from BlueScope. Local experts on the Illwarra economy were stunned at the small size of the response and the lack of thought that appeared to have gone into the biggest shake-up in the region since the 1970s.

The politicians appear to have ignored the fact that Wollongong is a university town and that this should probably be at the heart of any strategy for growth. The broader issue of the paucity of local infrastructure, which funnels all freight traffic into a single road to Sydney, has been left hanging. Improved rail links between Wollongong and Sydney were first discussed when Barrie Unsworth was NSW premier in 1988 but nothing much has been done despite the shifting of major port services from ­Sydney.

If the Illawarra region, which is home to the Port Kembla steelworks, is a microcosm of how Australia plans to manage the restructuring of uncompetitive industries then we are headed for trouble.

Related Quotes

Company Profile

The strong dollar is putting pressure on other sectors of the economy, including education, tourism and retailing, but there is no co-ordinated approach from state and federal governments about how to handle this. The last time Wollongong was hit with a major restructuring at the steel mill, state and federal government offices were shifted to the city.

BlueScope chairman
Graham Kraehe
and his CEO
Paul O’Malley
were forced into a tough decision after a combination of rising input costs, a higher dollar and low steel prices caused annual losses on exports of $250 million.

The $500 million cost of ending steel exports should be covered by the release of working capital associated with withdrawal from export markets. Kraehe is adamant the moves will put the company on a profitable footing and secure its future.

The closure of the No. 6 blast furnace is historic. The steel plant opened in Port Kembla in 1936 when Hoskings Bros shifted its operations from Lithgow. Its location was dictated by the local collieries. The Hoskings Bros business later became Australian Iron and Steel, which was bought by BHP.

When BHP spun off BlueScope as a separately listed company it did so in a way that lumbered the enterprise with a structural flaw that exacerbated the current problems it faces.

When BlueScope was spun off from BHP in 2001, there was a fierce argument put by the management of the steel company to keep within its structure the Illawarra coalmines. The argument was pretty compelling, including the fact that the bulk of the coal produced by the local collieries were consumed by the Port Kembla plant.

However, the then CEO of BHP, Paul Anderson, prevailed and decided to keep the coalmines within BHP’s control. BlueScope managed to maintain its position as an efficient and globally competitive steel maker through consistent cost ­cutting.

It was cutting about $50 million a year to remain competitive. It had operated under the rule that it needed to produce 5 million tonnes of steel a year to have the economies of scale necessary to be efficient.

However, the current management has taken the view that this is no longer a relevant number. Kraehe and O’Malley say BlueScope can be efficient with steel production of about 2.6 million tonnes a year, which is in excess of the 2 million tonnes a year of domestic consumption. BlueScope has attractive businesses in Asia. It operates in Asian countries with the sort of business model that is being pursued by most global steel producers. They process steel that is made in the lowest-cost producing countries.

Closing its steel export business should make it more attractive to investors and potentially to acquirers, particularly vertically integrated steel makers.

One potential merger partner that has been talked about for years is
OneSteel
, which was spun out of BHP in 2000. It was fortunate that BHP allowed it to keep its iron ore supply in the Middleback Range in South Australia, so it is not subject to the same raw material input pressures as BlueScope.

That decision has protected One­Steel from the soaring prices of inputs that helped make BlueScope’s output uncompetitive in export markets. The wisdom of being in the business of selling iron ore rather than steel can be seen from the company’s decision to buy the iron ore assets of WPG Resources for $346 million.

There are a number of issues that make a merger of OneSteel and BlueScope extremely complex. Under and Indenture Act in South Australia, the iron ore mines owned by OneSteel can only be operated if the Whyalla steelworks remains open. That removes the possibility of rationalising the steel plants under joint ownership.

The other issue that would hold back a merger is the likelihood that the Australian Competition and Consumer Commission would force the sale of one of the two distribution networks controlled by the companies. That would simply open the door to a foreign steel supplier getting a leg-up in Australia and causing more ­competition.

The $750 million hybrid issue by
ANZ Banking Group
says a lot about the strength of the Australian banking system at a time when international markets are growing increasingly nervous about banks in the United States and Europe.

Fears about the stability of European banks were heightened last week when one euro-zone bank tapped the European Central Bank’s dollar funding offering for $US500 million.

It was the first time in six months that a European bank had used the facility and was seen as an obvious sign of increasing stress in the US dollar funding of European banks.

Another measure of stress that is followed closely is the amount of cash held on the US balance sheets of ­foreign banks.

Analysts at Nomura had highlighted the fact that the cash balances dropped from $889 billion on July 20 to $758 billion on August 3. However, there was no further deterioration in the latest figures released on August 19. These showed that cash deposits on the balance sheets of foreign banks in the US had jumped back up to $US813 billion.

There are other signs of stress among European banks.

Analysts at Deutsche Bank have noted that there is a “slower moving, toxic funding crisis" emerging in Europe and it can be seen in the level of bank term debt issuance.

It fell in July and August. In fact August is so far the weakest month ever for debt issuance, at $US4 billion as of last Friday.

Deutsche said this was likely to force another round of balance sheet deleveraging and this was bad news for banks and also the wider ­economy.

Figures on debt issuance in Europe from Dealogic show that debt issuance plunged sharply in June at the time when concerns about euro-zone debt began to increase.

In the US, concerns about bank capital strength have prompted Bank of America to sell assets and cut jobs.